Further memorandum by the Department for
Transport, Local Government and the Regions (PRF 35A)

INTRODUCTION

1. This Memorandum provides the further
information requested by the Transport Sub-Committee in the light
of the High Court's decision on 7 October to grant an order placing
Railtrack PLC into Railway Administration. Several of the Sub-Committee's
supplementary questions relate to the Government's proposal that
a Company Limited by Guarantee (CLG) could take over Railtrack
PLC's railway assets and its role as Network Operator. The responses
below refer to this proposal. But the Sub-Committee will be aware
that there may be more than one proposal before the Administrator,
who is responsible for assessing and making recommendations on
proposals for transferring Railtrack's railway assets out of administration
as a going concern. Any such transfer must be approved by the
Secretary of State.

2. The fact that Railtrack PLC has been
placed in Railway Administration will of itself have no significant
effect on the Government's franchising policy. The Strategic Rail
Authority will continue to exercise all of its functions, including
its work on franchises and refranchising, until the implementation
of the Government's proposed streamlining of the regulatory regime.
Those functions would then be taken over by any successor body.

3. The SRA's "Strategic Agenda",
published in March 2001, explained that it saw a role for Special
Purpose Vehicles (SPVs) to finance major enhancement projects
in the future. Subsequently, on 2 April the Government announced
that it had agreed with Railtrack that it would now concentrate
on the maintenance of the existing network, improving safety and
the service for passengerswith other partners helping to
expand the network. The impact of placing Railtrack PLC into administration
does not affect this work and detailed proposals on the working
of SPVs will appear in the SRA's Strategic Plan.

4. To date, heads of terms for three replacement
franchisesChiltern, South Central and South West Trainshave
been signed. All of these now envisage the use of some form of
SPV to finance significant infrastructure enhancements. A successor
to Railtrack PLC will, however, be important to ensure delivery
of these replacement franchises.

5. The SRA is currently negotiating a potential
two year extension to GNER's East Coast franchise. It is also
progressing, with Railtrack, the design and development of the
East Coast Main Line infrastructure upgrade. The Government announced
in April that this would be taken forward as an SPV, rather than
by Railtrack alone, and this continues to be the case.

6. The SRA is reviewing the remainder of
its franchising programme in the light of the draft Statement
on Passenger Rail Franchising that the Government issued in July.
The Government does not expect this to be significantly affected
by Railtrack's situation.

7. A CLG would be a private company run
on purely commercial lines but without shareholders and consequently
without the need to pay dividends in return for equity funding.
Any operating surplus from the company would be re-invested in
establishing reserves and in developing the network. The CLG would
not be run by the Government or by the SRA. It would be run by
a highly professional board, tightly focused on delivering a quality
rail network, remunerated and incentivised accordingly and with
corporate governance structures comparable to that of a traditional
PLC. The Government is confident that incentive packages could
be devised to ensure that the CLG recruited and retained the very
best people. Incentives would be based initially on safety, meeting
financial and efficiency targets, and providing a quality service
to customers.

8. For funding purposes the CLG would have
the same sources of income as Railtrack had: property income,
track access charges and grant. Some 90 per cent of the company's
income would therefore be covered by stable long-term contracts.
Revisions to these contracts, for example to reflect any changes
to the regulatory regime, would be subject to independent regulation
in respect of the fair price to be paid for the outputs Government
wished to purchase.

9. The CLG would not need equity to raise
debt finance. The company would have the existing debt from Railtrack
transferred to it and would be able to borrow further from the
debt markets to the extent necessary. The cost of this borrowing
would depend on the company's credit rating and under the proposals
currently being developed the Government would expect the CLG
to have an investment grade (ie at least BBB) credit rating. The
Government anticipates that in practice lenders would view the
company as a very low credit risk and a sound basis for their
investment.

10. The CLG would operate with much lower
risks than Railtrack, concentrating on operating and maintaining
the infrastructure as well as undertaking small-scale renewals.
It would not undertake major new projects with all their attendant
risks of cost overrun. As described earlier, it is anticipated
that such projectslike the East Coast Main Line upgradewill
henceforward be undertaken by Special Purpose Vehicles (SPVs).
These are likely to be bespoke joint venture companies financed
by a combination of Government grant and private sector debt and
equity.

11. Neverthless, the CLG would need a "cushion"
between the risk of poor financial performance and debt providers
that equity would provide under the standard PLC model. This would
come from two main sources, which combined would allow the CLG
access to sufficient funds to cover foreseeable circumstances.

12. First, the Government would expect to
put in place an arrangement by which the company could access
a standby, subordinated loan facility. This facility would be
enshrined in a contract, providing explicit support in specified
circumstances up to a predetermined limit. It would be capped.
It would not amount to a Government guarantee of debt, but the
repayment of this facility would be "last in the queue"
of creditors for repayment. The possible value of this facility
would be determined once the Administrator has a better understanding
of Railtrack PLC's true financial position.

13. Second, since the company would not
be distributing profits in the form of dividends, it would earn
a surplus over direct costs. These would be sufficient over time
to build up a significant reserve.

RELATIONSHIPOFTHE PROPOSED
CLG TO OPERATING
COMPANIES

14. The Government believes that a CLG would
significantly enhance co-operation in the industry to the benefit
of Train Operating Companies and rail passengers.

15. The CLG that the Government is proposing
would be a private sector company with a fully professional board
comprising some 12 to 15 directors. The Government would expect
the executive positions on the board to include a CEO along with
safety, engineering, finance and commercial directors. The non-executive
directors would include a chairman, one director nominated by
the SRA and one appointed after consultation with the Train and
Freight Operating Companies. The board would be completely focused
on delivering a quality rail network fit for the 21st Century,
remunerated and incentivised accordingly, and with corporate governance
structures comparable to that of a traditional PLC. The Government
would expect to put in place incentive packages comparable with
those for similar roles elsewhere in the private sector, which
would ensure that the company recruited and retained the very
best people.

jf199>

16. Instead of shareholders, the CLG would
have members. The SRA would be the founder member of this CLG
and the Government anticipates that the majority of the other
members would come from the private sector. Individuals drawn
from private sector companies with a direct stake in the railways,
other interests including passenger groups and employees could
all be possible members. The members would have a role equivalent
to that of shareholders in ensuring the high performance and full
accountability of the board. The Government anticipates that operator
involvement along these lines would allow the CLG structure to
promote a more collaborative and co-operative approach throughout
the industry, the absence of which was one of the industry's weaknesses
when the network was under Railtrack's stewardship.

RELATIONSHIPOFTHE PROPOSED
CLG TOTHE
RAILWAY REGULATORY
BODIES

17. In other utility sectors, regulators
have the dual role of balancing shareholder and consumer interests.
As this would not be the case with a CLG model, it is the Government's
intention to streamline the regulatory regime. We recognise the
continued need for independent economic regulation and are considering
the details of this. Precise powers and responsibilities would
be set out in legislation.

18. In the meantime, the SRA and the Office
of the Rail Regulator would retain their existing powers and carry
out their respective functions. The proposed streamlining of regulatory
functions would not affect the Health and Safety Executive, which
would continue to oversee aspects such as the new company's safety
case.